The five-year term of the Dáil expired in June 1937. In the subsequent election De Valera and Fianna Fáil were returned to power and, in a simultaneous referendum, voters approved the new constitution. This document abolished the Irish Free State and established Éire as a "sovereign independent democratic state". The constitution provided for an elected president as head of state; a Taoiseach as head of government; and a two-house legislature, with a new 60-member Seanad.

Although it presumed to apply to all Ireland, its application in Northern Ireland was not to take effect prior to unification. It made no reference to the British monarch or to the Commonwealth, but De Valera indicated that Éire's relations with the United Kingdom would be governed by the External Relations Act of 1936. In 1938 the Irish writer and patriot Douglas Hyde became the first president of Éire, and De Valera became Taoiseach.

In 1938 a series of Anglo-Irish agreements on trade, finance, and defence were reached. They ended the tariff war between Éire and the United Kingdom, and provided for the withdrawal of British forces from naval bases in Éire in exchange for a lump-sum payment of £10 million to settle the annuities owed to Britain.

The slight improvement in relations between the two nations was marred by a violent terrorist campaign in mainland Great Britain conducted by the IRA, which included bomb attacks on railway stations. A breakaway fascist faction of the IRA tried to approach Nazi government representatives, but received minimal response. 

Éire remained formally neutral in World War II, thereby demonstrating its independence, but in doing so alienating many of the Allied powers, in particular the Unionist-controlled government of Northern Ireland. Many of its citizens, however, joined the Allied forces or worked in British war industries, and in practice Éire followed a policy of quiet co-operation with the Allies.

In the immediate post-war era, the economic dislocation in Britain and Europe subjected the economy of Éire to severe strains, resulting in a period of rapid inflation and, indirectly, in the defeat of Fianna Fáil and De Valera in the elections of February 1948.

John Aloysius Costello became Taoiseach, leading a coalition of five parties, the chief of which was Fine Gael, a party that had been formed in 1933 through a merger of Cumann na nGaedheal, the National Centre Party, and the quasi-fascist Blueshirt movement.

Costello called for lower prices and taxes, the expansion of industrial production, and closer commercial relations with Britain. In November 1948 he led the Dáil in passing the Republic of Ireland Bill.